Google “commodities supercycle” and scores of stories will pop up. At a glance, it might look like a crowded trade as the Commodity Research Bureau (CRB) index, which reflects a basket of a wide range of commodities, has soared over 80% since its April low. Shares of commodity-producing powerhouses, including BHP and Rio Tinto, have roughly doubled in the past year.
However, the rally may still be in early innings.
Commodity prices plunged sharply at the start of the Covid-19 pandemic and are now generally only modestly above pre-pandemic levels. More importantly, last year’s nadir marked the CRB’s lowest point since 1991. At a recent 203 the index isn’t even halfway to its all-time high of 470.17 reached in 2008. And the last commodities supercycle stretched from 2000 to 2014 after the asset class languished in the 1980s and 1990s.
Jeffrey Currie, Goldman Sachs’s global head of commodities research, argued in January that “the beginning of a much longer structural bull market for commodities” was underway.
The post-pandemic economic backdrop helps explain why this rebound may only be beginning. “Thanks to fiscal and monetary stimulus, we have expectations for a pretty robust and synchronized global economic recovery,” says Roland Morris, a portfolio manager and strategist for the Commodity Index Strategy team at VanEck.
“We’re already seeing a strong rebound in manufacturing,” which has led to a sharp increase in demand for many factory inputs such as industrial metals and energy.
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To be sure, China, which has had a seemingly insatiable demand for commodities of all stripes over the past decade, may not be as strong a driver in the years ahead. Analysts at Merrill Lynch noted late last year that “there have been longstanding concerns that commodity demand in China may fall outright going forward on headwinds from demographics and a reconfiguration of the country’s economy.” China’s birth rate is estimated to have dropped 15% in 2020.
Yet other factors point to an extended upturn in commodities, including limited supply. Commodity prices have been in a prolonged funk, which has disincentivized miners from exploring for new drilling sites to find industrial and precious metals.
Martin says that “supply has remained tight because commodity producers have been under pressure to focus more on near-term profits and not long-term capital investments.” The silver lining: “These producers should greatly benefit from rising prices.”
The impact of firming demand and constrained supply is apparent with industrial metals like copper. The StoneX Group predicts that the global copper market is looking at a 200,000 ton shortfall in copper production this year relative to end demand.
Priced in dollars, commodities have benefited from the currency weakening this past year. And though the core consumer price index rose less than expected in February, U.S. inflation expectations recently hit a decade high amid a sharp increase in the 10-year Treasury yield that has in recent weeks pressured stocks, particularly tech names. With inflation presumably a greater concern for advisors, commodities can provide an inflation hedge for client portfolios.
Bond strategists at PIMCO have noted that “commodities are one of the few asset classes that tend to benefit from rising inflation. As demand for goods and services increases, the price of those goods and services usually rises as well, as do the prices of the commodities used to produce those goods and services.”
To be clear, we are not yet in an inflationary environment. In the U.S., the personal consumption expenditures (PCE) price index remains below 2%. But expectations of rising inflation as the global economy powers up are top of mind for strategists and advisors. As economists at ING note, “there now appears to be a self-feeding virtuous cycle between rising commodity prices and inflation fears.”
Gold is often seen as an inflation hedge but doesn’t tend to benefit from firming economic activity to the extent that industrial metals do, such as copper, nickel, and zinc.
And even some commodities that are seeing near-term strength from rising economic activity may not be ideal longer-term investments. Oil consumption, for example, is likely to be blunted by global carbon-related regulation that seeks to address climate change concerns. Since the price of West Texas Intermediate light sweet crude oil futures collapsed to below zero last spring, futures have soared to about $64 a barrel.
That underscores a big challenge for commodity funds. The Invesco DB Commodity Index Tracking Fund (DBC), for example, has 63% of its assets invested in fossil fuels. In the iShares S&P GSCI Commodity-Indexed Trust (GSG), that figure hovers around 50%.
In 2019, the VanEck fund managers slashed the fund’s oil and gas exposure from around 47% to about 15% today, according to Morningstar analyst Kevin McDevitt. VanEck’s Morris attributes the shift — and recent gains — to a greater focus on industrial and precious metals, many of which will see rising demand for use in electric vehicles, global energy demand, and new home construction.
Though silver is considered a precious metal, roughly half of it is used for industrial consumption, including as a key ingredient in the production of solar panels. Global demand is expected to rise to an eight-year high this year, according to the Silver Institute.
Lithium, cobalt, and nickel are used in large quantities for advanced batteries. And copper is a key ingredient in plumbing systems for residential and commercial spaces alike. Regarding the VanEck fund’s new focus, “we think this is the proper positioning for the road ahead,” said Morris.
As the commodity landscape evolves, look for more funds to focus on the shift towards a decarbonized economy. As one example, the Blue Horizon BNE (BNE) ETF launched this past December. While the fund is likely too new and too small for most portfolios, its approach helps shed light on the direction of commodity investing.
Govind Arora, co-founder of Blue Horizon Capital, says his fund owns 100 companies that “will drive the new energy economy.” John Mitchell, the firm’s other co-founder adds that the fund focuses on three core drivers: firms that are technically innovative, firms that address climate change, and firms that are well-situated from a supply, demand, and pricing perspective.
If that new ETF lacks the critical mass for most accounts, advisors can consider the New Alternatives mutual fund (NALFX). The fund, which has surged 52% in the past 12 months, carries a 3.5% sales load, 1.08% expense ratio, and invests in mature clean energy firms that tend to produce robust cash flow.
James McKeigue, Managing Editor of LatAm Investor emailed RIA Intel indicating that while Latin America accounts for roughly 10% of global GDP and a similar share of the planet’s population, the region produces outsized amounts of metals. In addition to its strong position in gold and copper, Chile accounts for 20% of zinc output, 51% of silver, and 20% of iron ore.
“In lithium, which is set to be another beneficiary of green stimulus, the lithium triangle of Chile, Bolivia, and Argentina holds more than half of the world’s global reserves,” notes McKeigue.
The impact on mining volumes and pricing in this region can be dramatic. Chile, for example, derives more than 10% of its GDP from copper production, according to the International Copper Association, which estimates that “the industry has also created hundreds of thousands of jobs, both direct and indirect.” Both government finances and consumer spending get a strong lift when commodities are in an upcycle.
Axel Christensen, Chief Investment Strategist for Latin America at BlackRock, wrote via email that demand for copper from Chile should “extend beyond the Covid recovery stage and extend several years.” He notes that “electrical vehicles, for example, require much more copper than traditional combustion cars. Therefore, we could experience a true ‘supercycle’ for copper,” as well as with lithium.
As Chile’s economic fortunes slid in recent years and copper prices sagged, the iShares MSCI Chile (ECH) ETF fell in price from the low $50s in 2018 to below $20 this past March when the Covid-19 pandemic tightened its grip.
Since then, rebounding industrial metals pricing has helped propel the fund by more than 60% to a recent $33. Still, there is ample room for this country fund to revisit those 2018 highs, let alone the $80.27 peak it reached in 2011 during the last commodity supercycle.
Based solely on traditional commodity fund approaches, a still-heavy exposure to crude oil may eventually blunt talk of a commodity supercycle. Yet funds that more squarely focus upon the commodities that will underpin the new energy economy may indeed be on the cusp of a long and sustained rally.
David Sterman, CFP, is President of New Paltz, NY-based Huguenot Financial Planning
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